The House Has Got to Go – 2 Bedroom Apartment Here We Come

house

Opportunity Cost: The loss of potential gain from other alternatives when one alternative is chosen.

Confession: When I said I would seriously consider downsizing our home, I was only sort of telling the truth (so much for defeating denial). Yes, I’d evaluate the costs and benefits of downsizing, but there’s no way I’d really get rid of our house, I said to myself.

Maybe that’s still true – maybe there’s no way my wife and I would leave a home and neighborhood we love for the sake of accelerating our savings. But after a couple of hours with Excel, I can now say that staying in our home is purely emotional, because financially it makes no sense at all.

Check out this table:


Housing Alternative Savings 3 Yr Value 5 Yr Value 7 Yr Value 10 Yr Value
Rent Similar Home $310 $12,450.54 $22,323.26 $33,674.98 $53,969.29
Rent Townhome $710 $28,515.75 $51,127.47 $77,126.57 $123,607.07
Rent 2-bedroom Apartment $1,135 $45,585.03 $81,731.95 $123,293.89 $197,597.22

Notes:

  • ‘Savings’ estimates the difference in cost between our current home and the alternative, and includes estimates of the value of the mortgage tax credit, maintenance on the home, utilities, and HOA fees.
  • This table assumes a meager 7% return on the saved amount. If the money earned 10% per year, the 2-bedroom apartment would pay out nearly $235,000 in ten years. Yikes.
  • My wife may threaten divorce if I use this table to try to get her to move.

When I showed Jesse this table, he took it to another level: after ten years of renting, we could go right back to our current cost of living, let the $200k sit in the market for another ten years (when I’d be reaching my goal retirement age of 54), and have around $400,000 extra in savings. Four hundred grand (or $470,000 with a 10% interest rate on the savings).

Summing up: If I lived the next 10 years in a 2-bedroom apartment – investing the savings along the way, the end result could be an additional $16,000+ per year in retirement.

I don’t know what else to say about it. We love our home and our neighbors. We’ve planned to be where we are for a long time – maybe forever.

But these numbers aren’t unreasonable. It’s one thing to grasp the total cost of home ownership in the traditional sense (principal plus interest), but adding in the cost of lost savings is making the house feel really, really expensive.

 

Handling Offset and Redraw Accounts in YNAB

G’day!*

I’m Ian, one of the YNAB development team. Nice to meet you!

Jesse has asked me to explain how to use YNAB to handle some mortgage situations that occur frequently here in Australia, but aren’t quite so common in other parts of the world. Specifically, how to deal with mortgage offset accounts and mortgages with redraw facilities. My wife and I bought a house in the Blue Mountains (in New South Wales roughly an hour and a half west of Sydney) about five years ago. Our home loan had an offset account attached to it, and after we refinanced in 2011 we found ourselves instead with a redraw facility as part of our loan. So I’ve dealt with both of these in my own budget and can (hopefully) explain how I’ve dealt with them in the YNAB software. Both of these account types provide a way for you to pay down your mortgage more quickly, while at the same time maintaining access to your money if you really need it (which is handy).

Offset Accounts

Offset accounts are a transaction (“checking” for our US-based friends) account that is linked with a mortgage so that when interest is calculated on the mortgage, the balance of the account is offset against the principal of the loan. This means the higher the balance you have in your transaction account, the less interest you pay. So the goal is to keep that balance as high as you can. The good thing about offset accounts is that they are very easy to manage in YNAB – they are simply a standard checking account. So, you don’t need to do anything differently to how you would normally use YNAB. Build up your category balances for rainy day funds and the like, and just leave that money in the account. If you want to, you can create an “offset funds” budget category, and budget money into that, which means that you will be building up extra padding in your account and as long as you spend according to your categories (and not your balance) your loan interest will decrease. You budget your regular mortgage payments as usual, using a regular budget category.

To represent the actual loan in YNAB, you can add that as an off-budget loan account if you want to see it being paid down over time, in which case your payments are a transfer from the offset account to the mortgage account, categorised using your mortgage payment category (because money is leaving your budget). When you receive your statement, you can add the interest as an outflow from the mortgage account.

If you don’t want to see the mortgage itself in YNAB, it’s even easier – all you need to do is create a mortgage budget category, and make an outflow with that category each time you make a payment. Fair dinkum**, it’s that simple!

Redraw Facilities

Having a redraw facility attached to your loan allows you to pay extra into your home loan and then redraw that money at a later date. This can either work by allowing you to transfer the money back out to another (pre-specified) account, or may allow you to spend directly from the home loan account. Unfortunately, managing redraws in YNAB is slightly more complicated than the ease of offset accounts.

The reason for the complication is because a redraw account is both a budget account and an off-budget account. At the same time. Unfortunately we don’t have anything built into YNAB to handle this sort of craziness, so for now we have to deal with it manually. And that means we need two accounts in YNAB to represent the single real-world account.

The first account is the actual mortgage account, created off-budget, with the starting balance equal to whatever remains on the loan (not including any funds in the redraw portion of the loan account). I’m going to use some easy numbers for examples here, so it’s easier to see what’s going on. In this instance, we’ll say we have a mortgage for $100,000 (I wish my mortgage was only for $100,000, but houses are expensive Down Under***).

The second account is the redraw portion of the loan account. It is created as a checking account, with a starting balance of whatever funds are available to redraw. For this example, we’ll say we have $20,000 extra that we have paid into the loan. This could be from a combination of rainy day funds, extra payments, and using the loan instead of a savings account. Personally, I put the bulk of my pay into this redraw account, and pay my credit card and the other bills from there.  At this point, we have two accounts in YNAB representing our home loan. When the two balances are combined, they total $80,000 remaining on the loan, but we can access $20,000 if we want to.

At this point we can actually start spending from the redraw portion, as well as paying down our home loan. My loan provider won’t let me pay the mortgage from the redraw portion, so I have to maintain another transaction account in order to pay off the home loan.

It should look something like this on the sidebar:

 redraw1

When we look at our loan statement, it will say that we have a balance of $80,000, because the two home loan accounts in YNAB are combined in Real Life™. Shown below are a series of transactions as an example of how to represent spending. Payments for the home loan are transfers to the off-budget portion of the loan (again with a category, because money is leaving your budget). Interest on the home loan is added as a standard transaction. All other payments come and go from the redraw portion of the loan.

redraw2

As you can see, I got paid into the home loan**** and paid for my credit card from the redraw portion of the loan account, as this money hasn’t explicitly been used to pay down the loan. The monthly payment went to the non-redraw portion of the account, and interest was applied there as well, because those are directly applied to the loan itself.

The sidebar now looks like this:

redraw3

You may have noticed that I had flagged all the home loan transactions with the same colour***** flag. I do this so I can reconcile the account. Reconciling in YNAB only works on a single account, so we have to manually ensure these combined numbers are correct and then we can lock down the individual portions. By giving all transactions in the two home loan accounts the same flag, it makes it easy to filter. So, going with a statement on 4/3/2013******, we can change to All Accounts and set the filter to the following: redraw4

At this point we can confirm that the statement date of 4/3/13 and loan balance of $79,600 to pay is correct by looking at the total in the footer. If we are missing a transaction, we can just add it here directly (making sure to flag it the same colour), and if we need to unclear some of the transactions to match the statement, we can confirm the total is still correct by adding “Is: Cleared” to the search filter.

Once we are sure our total matches the statement, we can reconcile the two YNAB accounts separately by making sure every transaction after the statement date is uncleared, and then clicking “Reconcile Account” and entering the statement date. The cleared total is automatically set there, so we can just click “Finish Reconciliation”, and we’re done!

That’s it!

As you can see, it is a little more complicated to handle a redraw account, but after reconciling once or twice, it gets much faster to manage. It takes me considerably less time to reconcile our home loan than it took for me to write up how I manage it.

Thanks for joining me on this little excursion into Australian home loan features and how to manage them in YNAB!

Cheers,

-Ian

 

*I have to say that because I’m Australian, and it’s written into our constitution that all international communications have to begin with “g’day” on pain of capital punishment.

** This isn’t in our constitution, but I say it here to re-establish my antipodean credentials

*** We never actually say “Down Under” in Australia

**** My pay for March hasn’t cleared yet, but I have a full buffer, so I’m ok

***** There is a “u” in there. “Co-lor” sounds like a B-movie alien invader name

****** That’s March 4th, not April 3rd

Short-Sales and Foreclosures – The Bank Might Not Make You Pay, But Don’t Forget About Uncle Sam!

Considering the current Real Estate downturn, there is a pretty good chance that some who read this blog are in the process of losing their homes. Hopefully the percentage of readers in this situation is smaller than the national average because you have learned to budget well. Even if you are not in this situation, there is a really good chance that you know someone who is and, if so, this article may help them know what to expect from a tax standpoint.

The Way it Normally Works

The IRS looks at all debt that is reduced or forgiven in one way – as taxable income! Why? Because then they can tax it! No, it actually makes sense. If you owe money and the debtor forgives the debt, what that really means is that they paid the debt for you. If they paid the debt for you it is the same as if they paid you and then you paid the debt. So, the debt paid is considered income. (Another way to think about this: If this were not the case then we could all have our employer just by our food, housing, entertainment, etc. and we would never have any income to report and no one would ever need to pay taxes.) Since the debt that is reduced or forgiven is income you may now owe income tax on that portion that was eliminated. So not only did you lose your house because you couldn’t make the payment, but now you have a big tax bill to boot!

Relief for a Short Period of Time

Because the housing crisis is so big, and in an effort to lessen the economical impact of the foreclosures, in December 2007 President Bush signed the Mortgage Debt Forgiveness Act of 2007. The act allows for mortgage debt relief to not be included in income for those whose mortgage debt is forgiven between January 1, 2007 and December 31, 2009. So, if losing your house is inevitable, I guess now is a “good” time to do it.

Some of the “Nitty Gritty” Details

Probably the most important footnote to this is that only the portion of debt that was used for the construction, purchase, or significant improvement of the home qualifies for the benefits of the Act. In other words, if you used part of the money from your mortgage to consolidate debt or pay for a vacation, etc., then that portion is still considered income and is subject to taxes. For example, if the amount of money used for things other than the home is $55,000 and the amount of debt forgiven is $90,000, then only $35,000 of the debt relief is not included in taxable income.

A second important note is that this tax relief only applies to a principal residence. So, if it is a second home or a vacation home then the debt forgiveness will be treated as it always has – taxable income.

There are a few other details to the Act as well, but they don’t apply to most people and/or they aren’t within the scope of this BLOG. My intention is just to give you an idea of the overall tax consequences of debt forgiveness and the effects of this Act.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

Don’t Buy Into the Home Equity Line Buzz

I have heard a lot of frenzied comments and illogical notions regarding home equity lines of credit in the last two weeks. The news media have been reporting, correctly, that many banks are beginning to freeze equity lines and not allow people to take out any more credit. Along with that, many are suggesting that you should take out everything you can get in your credit line before they freeze yours too. Please, think before acting when it comes to this decision!

Some Background

Over the past few months, because of the credit crunch, some homeowners have been receiving letters from their banks indicating that their home equity lines of credit are frozen – meaning they cannot get any more money. The letter may say that it is because of declining values of homes in the area, or for many other reasons. Sometimes it may be for no reason at all, other than the bank wanting to decrease its exposure to the current markets. Don’t be offended or let pride get the best of you! This may not be a terrible thing. Case in Point:

I was at a meeting of local business owners this week. As we were discussing various things one of them said that he had received such a letter. The bank told him that his home (which he then described in detail and said had been appraised three years ago at $1,000,000) was now only worth $450,000 and so they were not able to extend him any additional credit and had frozen his equity line. He was upset and paid $400 to an appraiser to prove to the bank that his home was worth much more. The appraiser said that it was worth $625,000. Did the bank budge? No. And now he is $400 poorer.

Don’t Rush to “Get Your Money While You Can”

First, remember that this isn’t your money that they are freezing. They just aren’t giving you any more of their money. I have read articles in some very respectable publications urging people to take out the remainder of their credit line in a lump sum so that they have it when they need it. To me this is ludicrous. Yes, there are potential tax advantages to this kind of loan. Yes, the interest rates on these loans are often lower than many credit cards. But you are still paying interest. And, by definition, any tax benefits will only be a percentage of that interest that you pay. The real question is, do you really need the money?

If you are in real need of a loan and the best way for you to get it is through your equity line, then you may want to take some out now while it is still available. But please don’t increase your debt “just in case.” Would you spend $10,000 on your credit card just to have an extra $10k in your savings account? I hope not. In many ways, jumping on this frenzied equity-line-band-wagon is just the same.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

On Home Buying

We are about a year and a half removed from our first home buying experience. Reflecting on the purchasing process through the clarity of hindsight, I’ve compiled a bit of amassed wisdom I’d share with other first-time buyers:

Slow Down. There will always be great houses, with great yards, in great neighborhoods on the market. And there will always be good deals. Abandon the scarcity mentality, especially in the present market that is, and will continue to be, plump with anxious sellers. Wait not just for a good opportunity, but for the right opportunity.

Don’t fall for the “rent = throwing away your money” myth. Renting is not throwing away your money — it is exchanging your money for a roof over your head. And, depending on your circumstance, the flexibility that comes with renting can be extremely valuable. Also remember that much of the money that is lumped into the term “mortgage payment” is essentially rent. Consider how much goes to taxes, interest and insurance, and you’ll realize that there is, in fact, just a small portion of what you send away each month that translates into actual equity.

Keep an intensely accurate budget for several months preceding the purchase of your home (especially your first home.) Be familiar with utility rates, maintenance/repair fees, and fixed expenses so that you know exactly how much you can comfortably afford to allocate for a mortgage payment each month. In addition, carefully consider the increased expenses that often come with ownership (new appliances, yard maintenance and equipment, higher utility bills if you’re moving to a larger residence, increased fuel costs if you’re moving farther from work, etc.) Familiarize yourself with all the financial implications of ownership and make sure you still have a cushion to absorb the shock of unanticipated home maintenance or just the rising cost of daily living that so often takes us by surprise. The flood of foreclosures on the market at present is evidence of the fact that many recent buyers were overly optimistic about what they could afford.

Don’t get emotionally attached. I know. Easier said than done, right? But if there is one thing that will help you make a more astute financial decision with regards to the purchase of your home, it is this principle. Be willing to walk away from a seller who won’t negotiate into your price range. Understand your “Best Alternative to no Agreement,” (that you will be able to find another suitable residence,) and be willing to walk away from a deal that is not right. Don’t make emotional concessions (i.e. I love this house SO much that I’d be willing to spend a little less on food every month and buy less clothing to be able to live here,) that will stretch you beyond your predetermined price range. A house will not sate your desires and fill your happiness quotient like you might imagine. The granite and stainless will lose their luster remarkably quickly if you’re stretched to (or beyond) your financial limits month after month to afford them.

Buy with your values in mind. Be thorough and thoughtful in establishing your criteria for a home before you start looking. Consider things like commute distance, yard size, proximity to shopping, schools, parks, etc., and let your predetermined values guide your search and ultimately your purchase.

Finally, when trying to nail down the right mortgage, remember these things:

Money is a commodity. You are trying to find the lending establishment that will get you the most affordable money (i.e. money with the lowest interest rate and closing costs.) Approach the process with that kind of objectivity in mind.

Get five ballpark estimates from mortgage brokers based on a set of realistic assumptions about your financial situation.

Go back to the most competitive three ballpark estimates and ask for a “good faith estimate” based on your credit score and down payment capacity. It’s generally poor policy to come in much over a good-faith estimate, so these figures should give you fairly accurate ideas about rates and closing costs on a mortgage.

Take the best of the three good faith estimates to the other two bidders and see if they’ll come down from their original quotes. Let the mortgage establishments bid each other down; find out how badly they want your business.

Avoid interest only and adjustable rate mortgages. Beware of prepayment penalties and other fine print that often accompanies sub-prime loans. It is generally best to wait until you can afford a fixed rate, traditional mortgage.

We received almost all of this advice in some form or another prior to our home purchase; we gave strict heed to some suggestions and not so much to others. We’re happy in our home and comfortable in our mortgage and still, in hindsight, I wish we’d let all of these principles guide all of the decisions that affected such a substantial budget and life-altering commitment.

40 year fixed rate mortgage: In debt for 40 years?

I ran into this article about 40 year fixed rate mortgages at Bankrate.com and I just couldn’t let it slide without a bit of comment.

Okay, so people are starting to look at 40 year mortgages because they want to squeeze a few extra bucks a month off their mortgage payment. According to the article, with a $200,000 loan, you’re looking at saving on your mortgage payment less than $64.

But how much is the extra ten years going to cost? In the first five years of your mortgage (and we all know that most mortgages don’t last much longer than 5 years), you’ll pay an extra $3,500 in interest. Oh, by the way, guess how much equity you built in your house during the first five years when you elect to stay in debt for 40? $6,500. More than $7,000 less than on a 30 year fixed-rate mortgage. Sheesh, if housing happens to be somewhat stagnant, you’ll be lucky to come out even a bit ahead after closing costs.

“It allows you the opportunity to have a lesser payment, and for many people it gives the luxury of choice,” says Jim Sahnger, a broker with Palm Beach Financial Network in Sewall’s Point, Fla.

Alright, first, Mr. Sahnger is a broker. He makes money when you take out a mortgage. I can promise you that selling you a 40 year fixed rate mortgage will be much more profitable than selling the 30 year counterpart.

No conflict of interest there.

What Mr. Sahnger says really burns me. He mentions that having a “lesser payment…gives the luxury of choice.” First of all – $64 measly dollars gives more choice? Okay… And second, since when has someone in debt had more choice than someone not in debt? When you are in debt you are obliged to pay, as the Bible says, you are “slave to the lender.” So who really has the luxury of choice in the long run? The person who choose to live debt-free. What does debt-free mean to me? Your house payment, on a 15-year fixed rate mortgage, is at most 25% of your take-home pay. Other than that, you shouldn’t owe anybody anything. And congratulations, you just found a house you can afford.

They will compete with interest-only mortgages. Those, too, were a niche product until home prices began zooming in parts of the country three or four years ago. Now interest-only loans occupy a big chunk of the mortgage market in high-price cities as buyers hunt desperately for ways to afford absurdly expensive houses.

And please, don’t get me started on interest-only mortgages! Alright, why are home prices zooming? Because sellers are willing to pay that price. Why are they willing to pay that price? Because their monthly payments are jimmied low enough using financial instruments such as interest-only mortgages or these 40 year fixed rate mortgages. So, buyers “hunt desperately for ways to afford absurdly expensive houses” (italics added).

That’s an interesting (and wrong) use of the word “afford”. The applicable definition of that words is as follows: “have the financial means to do something or buy something”. I’m sorry, but if you need to pay only interest for the first 3, 5, or 10 years of your mortgage, or if you have to stretch the payment to 40 years, you cannot afford the house you so desparely want. Think smaller, or continue renting until you have saved more money for a downpayment.

Being debt free will give you the “luxury of choice” you want so badly. Do not proceed to attach ankle weights to your legs before beginning a marathon, and please don’t take a 40 year mortgage to “afford” a house you can’t.

Should I Pay Off My Mortgage Early?

Let me warn you right from the get-go. You’re hearing this from a guy that is pretty darn close to totally anti-debt. Now that I’ve disclaimed my bias, let’s discuss briefly an early mortgage pay off. Should you do it? Maybe.

I discussed a lot of the issues with mortgages, interest, saving that interest, tax-deductible interest, etc. in a discussion on the 15 vs 30 year mortgage question and the tax advantage of owning your home.

We’ll just breeze over the issues once again here, then you’ll be armed with the information you need to answer that immortal question: Should I pay off my mortgage early?

Alright. Everyone needs a roof over their head. There’s a cost involved there, whether you own your home outright or are still trying to pay off the mortgage. You need shelter. That’s a fact of life.

It is relatively easy to get quite a bit of money from the bank and be pretty well leveraged with your mortgage. I mean, you can get a loan-to-value of 5% ($5,000 down on a $100,000 home) pretty easily these days. I would say an LTV below 10% is pretty highly leveraged. This can be very advantageous with a mortgage.

Mortgage rates are extremely low right now (May 2005). This is cheap money! That is another advantage to a mortgage.

Your interest is tax-deductible. This makes an already cheap interest rate even cheaper!

The disadvantages of a mortgage? The interest cost is huge. For a $120,000 home, you could easily be looking at $170,000 total interest on a 30-year mortgage! Another disadvantage is the fact that you lose that monthly cash flow. If your home were paid off you could put those monthly “payments” to good use in an investment. Also, there is a lot of peace of mind that comes from not owing anybody anything. And you wouldn’t.

Consider the following scenario before you decide if you should pay off your mortgage early. Let’s take Ron, who is just crazy about owning his own home. He has an emergency fund in place with 3-6 months’ expenses. So he just goes to town paying off his 30 year mortgage in 13 years by paying an extra $300 per month. The result? In 13 years his mortgage is paid off.

But what could he have done with that $300 over the last 13 years? Invested it in the S&P 500. What would it have grown to? Without calculating all of the numbers, we can be reasonably assured that it would have amounted to a lot more than the interest he saved when he decided to pay off his mortgage early (alright, alright, his investment would be worth just above $95,000 invested at 10% for 13 years).

The general rule is this: if you have to decide between the early mortgage pay off or investing that surplus cash into something else, you would financially choose the one with the highest return (your after-tax interest rate is your rate of return because every dollar you spend paying it down is a dollar you don’t have to pay interest on). So if you can invest that $300 at 10% in a tax-conservative (low turnover) S&P 500, or save 6% after-tax, you would always choose to invest the money.

Is that 10% guaranteed? Heavens no! But over the long-term you’d be hard pressed to make an argument otherwise. Is that 6% return guaranteed? Heavens yes! That must be included in your decision to pay off your mortgage early.

I think Dave Ramsey has a pretty good plan. You need to make sure your foundation is well-laid before you consider paying off your house early. And this is coming from a guy that is about as anti-debt as you can get. He counsels his listeners and fans to follow his baby steps 1-5 before paying off the house. Why? Because steps 1-5 include getting together an emergency fund, getting rid of all debt excep the house, investing 15% in retirement, contributing to college funds for kids and then finally paying off the house early.

What this amounts to is that if you are already sitting on 3-6 months’ expenses in cash (money market, savings account, i.e. liquid), you don’t have any debt except for your house, you’re contributing 15% towards retirement (taking advantage of those possible 10% returns from the stock market and the great tax benefits that come along with investing for retirement), you’re even planning on helping your kids out with college, and you still have excess cash left over to pay off your mortgage faster? Man – go for it!

Forget about the possible 10% return of the S&P – you’re already making a killing contributing consistently 15% of your income – make a guaranteed return of 6% on that excess cash. And when you’ve paid off the house, take that payment you were making and go on a cruise. When you get back from the cruise, start socking it away for retirement.

15 vs 30 Year Mortgage: A Risky Dilemma

I’m going to attempt to answer the age-old question: 15 vs 30 year mortgage: which is best?

And I hate to break this to you, but it all depends (and I’m not even going to mention taxes here).

I want to start off with a table (it’s the accountant in me) outlining some basic assumptions when answering the 15 vs 30 year mortgage question. Hopefully this sheds a bit of light on these different mortagages right off the bat:


  15 vs 30 year mortgage
  30 year 15 year
Loan: $175,000 $175,000
Rate*: 5.41% 5.01%
Payment: $984 $1,385
 
Total paid: $354,158 $249,264
Total interest: $179,158 $74,264

* Rates taken from BankRate.com on 18 April 2005.

Alright, if you only looked as far as the payment line, you might’ve received a bit of a jolt. The 15 year mortage requires you pay out another $401 per month for the life of the loan! Take a deep breath. You don’t pay anything else on the 15 year mortgage after 15 years (makes sense eh?).

If you checked out the last two lines of the table you might have received a jolt in the other direction. If you do a 15 year mortgage you will save $104,894 verses the 30 year mortgage!

Clearly the 15 year mortgage is the best option? It depends.

One thing you absolutely have to consider with the 15 vs 30 year mortgage question: opportunity cost.

Consider this: what if you did indeed take a 30 year mortgage, saving $401 in monthly cash flow, and invested that $401 each month for the life of your mortgage? If you invested it in a mutual fund earning 9% (let’s not get into a debate about potential stock market returns at the moment), that investment would grow to $734,181!

So clearly your best option is to pass up the 15 year mortgage, stick with the 30, and invest the difference in savings. Not quite.

First off, you have to remember the extra interest cost (remember, I’m not including taxes in the analysis), of the 30 year mortgage: $104,894. So you’ll need to reduce that investment amount from approximately $730k to a more appropriate $555,024.

Well, still another half million dollars makes the 15 year an inferior choice. No, not quite.

It’s not fair that you can invest the difference in savings for those 30 years without looking at the 15 vs 30 year mortgage question from a different angle. If you take the 15 year mortgage, you’ll have that entire payment available for investment once you’ve paid off your house.

So, in actuality, we need to compare the two side by side. Taking the 30 year mortgage allows you to save $401 for the life of the loan. If you take the 15 year mortgage, you’ll not save anything for the first 15 years, but then you’ll have $1,385 to invest for the last 15 years. What does that investment equate to? Again, using 9%, $1,385 invested monthly for the second 15 years results in a value of $524,017. Does that mean the 30 year mortgage is about $30,000 (555,024-524,017) better? Nope. You’ll need to take the interest cost out of the 15 year mortgage value just as you did with the 30 year. With this analysis, the 30 year mortgage outpaces the 15 year mortgage by $105,271.

Ah ha! Clearly the 30 year mortgage is the best choice for your finances. Um, maybe.

We have assumed a 9 percent return on your investment of that $401 monthly savings. What happens if the actual return were only 5 percent? You would lose money. I used Excel’s “Goal Seek” tool to give me the required rate of return that $401 monthly investment would need to make someone indifferent (meaning you would break even) with the 15 vs 30 year mortgage question. The break-even rate of return is 7.82 percent. Basically, you would need to make sure you had a return 2.41% above your 30-yr fixed rate (assuming these BankRate.com numbers of course) to make sure you at least broke even. Any return below that and you would have been better off with the 15 year mortgage.

But we really should slow down and take a look at the personal side of personal finance. We really should be talking a lot more about peace of mind and a lot less about the numbers.

Consider this question: How much is your peace of mind worth? I personally believe one derives a lot of peace of mind from being debt free (I am completely debt free by the way). Is your peace of mind worth $105,271 over a 30 year period? Maybe I should break that down a bit. Is your peace of mind worth $292 per month? What I’m trying to get at here is this: to be debt free is something quite out of the ordinary – quite extraordinary in our day. The 15 vs 30 year mortgage question should be answered considering your peace of mind.

Honestly answer these questions:

1. Would you really invest that $401 savings?
2. Do you feel certain that if you did, your money would give you a return greater than 7.82 percent?
3. How would it feel to be completely debt free?

I ask you these questions because I think these answers will ultimately help you find the answer to the 15 vs 30 year mortgage question. If you answered “No” to question one or two, then I strongly encourage you to choose the 15 year mortgage. It guarantees you get out of debt in 15 years.

I personally have chosen to be debt free. It’s worth it!

“Tax Advantages” of Owning a Home

My objective in writing this article is to dispell a myth that should have been dispelled a long time ago when it comes to the tax advantages to owning a home. For purposes of my objective, a better title to this article should be “The Tax Advantages to Owing on Your Home” because you only get the tax advantages if you are in debt.

Really quickly, we’ll move through the tax advantages to owning (owing) a home. When you enter into a mortgage, as you probably know, a large portion of your monthly payment will go towards interest. As you pay down the principal, the interest portion of the monthly payment grows ever smaller, while the principal amount of your payment (the portion that goes towards actually paying down your debt) grows ever bigger. This interest is tax deductible if you choose to itemize your tax deductions. This tax advantage can be pretty lucrative for just about everyone – especially when you’ve first entered into the mortgage because you will naturally pay more interest.

However, it is a tax advantage. If you could choose to pay tax or pay taxes with an advantage, you’d choose the latter. That makes perfect sense. But never forget how this tax advantage actually becomes available.

You have to be paying interest.

Even savvy tax advisors will tell people the following: “Oh no, don’t pay your home off early. You’ll lose your tax deduction!” I feel sick to my stomach. Very well educated people tote this as a reason to stay in debt.

Would you like to guess who really pushes the tax advantages to owning (owing) a home? You got it–mortgage brokers, banks, loan officers, etc. They stand to profit from you stringing that mortgage out as long as you possibly can. They’re probably hoping you’ll take out an equity loan as soon as you get a chance too. There’s a conflict of interest if you’re taking advice from your lender when it comes to the tax advantages of owning a home.

The lender will give you, let’s say, a 7% interest rate. At the same moment he’ll tell you that the real rate or effective rate is only 5.6% if you’re in the 20% tax bracket, and 4.9% in the 30% tax bracket (you can get to these numbers with the following formula: interest rate * (1 – tax rate) ).

They never really mention that the tax advantage is only made available because you’re still paying them 5.6% or 4.9% on the loan.

Owning a home is a wonderful, wonderful thing. When I say owning I mean owning. You don’t make house payments. We’ll run two different scearios to drive home this point. Paying your house off early is and always will be better than having a tax deduction for the interest you pay.

We’ll use the following numbers:

  • Sale Price: $150,000
  • Down Payment: $30,000 (20%)
  • Interest rate: 7%
  • Tax rate: 25%
  • Time: 30 years


  Keep Mortgage Pay it off*
Total Payments $287,410.68 $222,987.11
Total Interest $167,410.68 $102,987.11
Tax Savings $41,852.67 $25,746.78
Total Cost $245,558.01 $197,240.33

*This assumes you make two extra payments per year towards your principal

By making only two extra payments per year you are out of debt 10 years faster and save $48,317.68! Remember, I’m including the tax “advantage” to owning a home in this calculation. Any way you cut the cake it’s still going to come out the same.

Finally, the tax advantage is there to promote home ownership, so I do appreciate it. It certainly does help. It is a nice benefit. But in no way does it outweight being entirely debt free with almost $50,000 saved as a result. Think about it this way–would you give me $1 to save $.25? Of course not. Yet that is exactly what you’re doing when you decide to not pay off your mortgage in favor of a tax advantage you will be giving up. That is a ludicrous idea. The numbers are here and they speak for themselves. Ownership will always be better than borrowing when it comes to funding your lifestyle securely.